Singin’ the IPO Blues

Why should we care that VCs aren’t getting rich?

It’s been a long time since technology venture capitalists got rich in these parts, or anywhere for that matter. I sat down with a longtime VC friend from Silicon Valley, who happens to be Canadian, and discussed the good old days. His former VC fund raised $110 million in 1996 (his firm’s fourth such fund) and it returned 50 times the capital (that’s $5.5 billion) by the time it was done in 2004. His investment firm raised a fifth fund in 1998 and it returned a mere 21 times.

The main factor behind these gushers of wealth in the 1990s was the technology initial public offering, or IPO. From 1995 to 2000, there were 1,354 technology IPOs in the U.S. The cheapest form of capital for a company and the best investment exit for a VC is in liquid capital markets, such as the NASDAQ. Returns to investors can be several-fold higher when investors can hold or sell their stock at will, as opposed to exiting their investment via a merger or acquisition, when the selling price is the selling price. Venture capital in the U.S. was built on the back of successes from IPOs.

After the technology meltdown of 2001, followed by the embarrassments of Enron, WorldCom, Tyco and others that led to public market reform, there have been a grand total of 300 technology IPOs in the U.S. From March 2008 to June 2009, there were none. Zero.

Canada hasn’t fared any better. Until recent filings by Mitel Networks and Avid Media (since withdrawn), there hadn’t been a technology IPO in Canada since Ottawa’s Bridgewater Systems went public in December 2007. The last B.C. technology company to do an IPO was Day4 Energy in November 2007.

Why is this a concern? Who cares if a bunch of VCs don’t get rich? Technology companies from B.C. predominantly sell to larger foreign companies anyway, right? Yes, there’s certainly some truth to that: worldwide, public companies represent 80 per cent of purchasers of companies where transactions are greater than $20 million. And here’s the big problem: if you look closely, these potential buyers of B.C. tech companies are disappearing.

Public companies buy other public companies as well as smaller privately held firms. This shrinks the number of public technology companies regularly. If the supply is not replenished, you have a shrinking number of potential buyers. To wit, the number of public companies on the NASDAQ (a reliable measure of 
the number of technology companies overall) was 4,734 in December 2000. By December 2009, that number had fallen to 2,250. In less than a decade, the number of large public buyers had shrunk by over 50 per cent.

A healthy IPO market is important not just for VCs looking for lucrative investment exits. Fast-growing technology companies depend on public offerings to finance their growth if they’re ever going to become potential acquirers of smaller companies. Without IPOs, the pool of big acquiring companies will continue to shrink.

With Cisco, Apple, Google, Microsoft and Oracle (representing a combined cash position of a staggering $146 billion) as your only buyers, they hold all the cards. In B.C. we have a few smaller public technology companies that are holding their own: PMC-Sierra, Sierra Wireless, MacDonald Dettwiler and Associates, Westport Innovations, Cardiome and Absolute Software. But we need more here too. We need the successes of days gone by, when Creo, QLT, Angiotech and Ballard Power were soaring. We almost had a bellwether IPO in 2004 with Crystal Decisions, before it was snatched up by a bigger public company, BusinessObjects.

The good news is that there have been more than 25 technology IPOs announced or priced in the past eight months in the U.S. There has been noise of more filings in Canada as well. Eventually, this trickle will get back to a more healthy flow of IPOs to replenish and even grow the number of public technology companies. And VCs will be happy once again. Lucky them. n

Brent Holliday heads the technology practice for Capital West Partners, a Vancouver-based investment bank.